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Don’t Stop Believin’


Tuesday saw yet another huge rally off of deep intraday lows. The stock market, at one point down nearly 3%, ended the day flat on heavy volume of 1.8 billion shares. The VIX, at one time during the day around 44, ended at 34.61.

These are not staid, sedate, institutional-style flows we are seeing. The common thought is that the volume and the swings are coming courtesy of hedge fund business, and I am sure that is part of it. However, I believe there is probably also some significant hedging of equity derivatives that is driving flows. Dealers who are short options, either explicitly or embedded in deals, tried to buy them back where they could (pushing the VIX higher) or, if the price is too egregious, they are forced to delta hedge. That would cause buying on rallies and selling on declines. Now, there’s no way for me to establish whether this is in fact happening, so it’s 100% speculation on my part. But the volume and the large swings in both directions just smack to me of short-gamma activity.

Swings in nominal fixed-income markets are more muted – the market just seems to move one way! The June 10y Note contract (which will shortly be deliverable and so open interest is rolling to Sep) rallied 16/32nds with the 10y yield falling to 3.17%. This happened despite the furious rally in stocks and the large jump in Consumer Confidence to 63.3! Remember, though, that Consumer Confidence is neutral at 100, so this level means that consumers are now finally as confident as they were at the absolute depths of the last recession (see Chart below, source Bloomberg).

The current "optimism" would have been deep pessimism in 2003.

By contrast, the ABC Consumer Comfort Index has barely moved off its lows and is well below the 2003 levels (see Chart below, Source Bloomberg).

ABC Consumer Comfort still near the lows.

The difference in these two measures captures a key insight into the Conference Board’s improvement. The former number includes a forward-looking expectations component, while the latter only measures current conditions. Indeed, if you compare the ABC figure to the Consumer Confidence “Present Situation” part of the index there is no discrepancy, as the chart below illustrates.

The improvement in confidence is all guesswork about the future.

This is less comforting to me than if the improvement was based on stuff that consumers were actually seeing, rather than what they were expecting to see. In a similar vein, the “Jobs Hard To Get” subindex, while improving slightly, hasn’t improved significantly at all.

And yet, on financial news networks today there were discussions about the “risk of a double dip.” A double dip? With Unemployment still well above 9%, shouldn’t we resolve the first dip first? It is hard for me to see how a second “dip” from here would be distinguishable as a second recession given the current levels of resource underutilization. But it is consistent with what Consumer Confidence is saying – people are looking forward as if they expect the expansion (an organic expansion, not one based entirely on government spending, as the recent quarters have been) to begin any minute. It is the same optimism that brought stocks to a level that was discounting such an expansion, and it unfortunately means that confidence may well be due for a depressing mark-to-market unless growth miraculously starts to boom.

There are few signs of that, and despite the rally back today market conditions are still ugly. The 2011 TIPS got cheaper still today, with inflation swaps down further, and bid/offer spreads on TIPS grew back towards levels last seen in late 2008 and early 2009. For the Jan-2011 TIPS, an 8-month piece of paper, the bid/offer spread quoted on one dealer’s screen was 14/32nds, for a grand total of $5mm size. The 10y TIPS are nearly 1 point wide bid/offer.

I don’t know what tomorrow brings, market-wise, but I remain pretty happy to not be a part of it. I suspect we still have further to go on the downside. Trending markets have bounces/retracements, but when a bounce happens intraday, like it did today, that often helps delay a longer bounce. Economically speaking, we will get data on Wednesday from Durable Goods for April (Consensus: +1.4%, +0.5% ex-transportation) and New Home Sales for April (Consensus: 425k). In the market’s current mood, I think these will be viewed as “old news” and not elicit a lasting reaction.

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Categories: Uncategorized
  1. John Millard
    May 25, 2010 at 10:15 pm

    Michael,
    Over the past year or so everytime the markets dive they seem to quickly catch some brakes. Huge volumes of shares are bought and the markets regain lost value. Some authors have theorized a government “plunge protection team” which seems probable to me… This diabolical thought came today. While artificially sustaining the markets they are at the sametime acquiring increasing ownership of american companies. Buying on the dips with their free cash, government could eventually gain controlling interest or powerful influence in all major companies. Two edged sword; comfort investors and the public by supporting the markets and buy up (socialize) the country.
    It’s uncomfortable having lost so much trust in our leadership.
    John Millard

    • May 26, 2010 at 7:16 am

      John – I hate to say that this thought DID cross my mind yesterday. In general, I am dismissive of PPT hypotheses for a couple of reasons. First, it would be really hard to hide the money, because we’re talking about a lot of money, and someone would have to know about it…not to mention that for at least some federal entities (e.g., the Fed) it’s illegal for them to intervene in this way. That being said, there aren’t a lot of reasons I can think of to be aggressively buying in a market that will certainly sell you all you want to buy on the bid side! And the buffoons in charge these days don’t have quite the respect for the rule of law that we’d like to see (ditto your comment about trust in our leadership!).

      But I guess there’s another reason to be skeptical that the PPT is involved: we’ve only fallen 12% or so from the highs. I can’t believe that’s a big deal for ANYONE after an 80% or whatever run-up, except perhaps for CNBC.

      All that said, I DID have these same thoughts yesterday when it was happening! (By the way, the existence of the PPT is not really disputed; the question is whether they actually have the power to sink huge sums into the market.)

  2. Fabio De Gaspari
    May 26, 2010 at 5:19 am

    Yesterday I’ve begun to buy TII 2.375 4/11, it seems to me a good opportunity, it’s a 0.65% real yield with a negative BEI of 0.65%, is it correct?? i’ve seen that estimated cpi for january is around 218.45, so much higher…
    I remember past sell-off in short Tips space, is it again possible? leveraged communities is again so active??
    what could be from this level a potential worst case scenario??
    Are not short euro inflation so expensive relative to comparables USA???

    I’m enough scared from markets, and accordingly keeping risk low, but in the meantime i’m wondering how bank balance sheets could repair with really high cost of capital and vanishing long term yields, at least in the beloved govies?? carry trade could be hard now…

    • May 26, 2010 at 7:21 am

      Fabio – 0.65% real yield is something close to a BEI of -0.25%, given where short rates are. This is cheap, but not super cheap, given how far energy prices have fallen. Also, in owning the Aprils you of course get the negative December seasonal. I agree that short Euro linkers are very rich compared to short US linkers, and I am not sure why that is.

      Clearly, some fast money has been selling these issues hard, and it isn’t clear why other than that they currently are able to do so and they want to reduce positions that could become illiquid in the near term.

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